Bernanke Has Already Told Us: More Stimulus Is Coming

Let us begin by stipulating that Federal Reserve Chairman Ben Bernanke will
be damned if he does and damned if he doesn't on Wednesday.

If he introduces a new bond-buying program or some other nontraditional
policy to goose the economy, Republicans will accuse him of debasing the
currency, creating the conditions for the next great inflation and encouraging
another cycle of capital misallocation. If he doesn't introduce anything,
Democrats will blame him for not doing his job to promote price stability and
maximum employment, as specified by the Fed's dual mandate.

Let us further stipulate that Bernanke is a man of his word. Agree or
disagree with his policies, he is a person of character. Therefore, we should
expect the Fed to announce additional stimulus at the conclusion of this week's
meeting.

Bernanke has been laying the groundwork for months. The minutes of the July
31-Aug. 1 policy meeting say additional measures "would likely be warranted
fairly soon unless incoming information pointed to a substantial and sustainable
strengthening in the pace of the economic recovery."

In his opening remarks at the Kansas City Fed's Jackson Hole Symposium on
Aug. 31, Bernanke said he saw little evidence that persistently high
unemployment was the result of structural changes to the economy, such as a
skills mismatch between employers and the unemployed. He called chronic
unemployment -- the unemployment rate has exceeded 8 percent for 43 consecutive
months, and 40 percent of the unemployed have been out of work for 27 weeks or
more -- a "grave concern."

An economy bumping along at 2 percent three years after the official end of
the recession doesn't meet the "substantial and sustainable" standard.

So what will the Fed do? Perhaps it will announce something akin to the
European Central Bank's open-ended bond purchases without the offsetting
sales.

Already in place is a second maturity-extension program of $267 billion begun
in June and set to continue through the end of the year, at which point the Fed
will have no more short-term securities to sell.

And a good thing it is, too, because if the Fed wants to stimulate demand, it
has to increase the size of its balance sheet, not simply reshuffle its existing
holdings. The obsession with long-term interest rates is misplaced. It's not the
price of credit that's preventing more people from buying homes, what with 30-
year fixed rate mortgages at 3.55 percent. It's access to credit.

The Fed is absorbing the bulk of the Treasury's new long-term debt, taking on
additional interest-rate risk and distorting the yield curve in the process.

Not that anyone at the Fed cares about the spread between short- and long-
term interest rates. Instead of being viewed as a harbinger of recession in 2006
and 2007, the inverted yield curve was dismissed as irrelevant. "This time is
different," we were told.

Nor do Fed policy makers focus on money, the missing ingredient in today's
monetary policy. Yes, the banks are holding $1.45 trillion in excess reserves,
and bank credit has been expanding since mid-2011. But money isn't turning over
fast enough to give the economy a real lift.

There are risks to doing more. The economy's problems could turn out to be
structural, not cyclical, in which case the Fed's medicine will create higher
prices, not more employment. If it injects too much money into the economy, the
Fed could create a new inflation threat. And the economy may be on the verge of
taking off, which is why some Fed officials want to wait for even more data.

The risks of doing nothing may be even greater. Inflation is a future risk;
current unemployment is a "grave concern." With words like that, Bernanke's
choice seems pretty clear.